OPEC Panics, Warns US Shale Not To "Assume" Production Cut Extension

All it took for OPEC to panic, was the sharpest drop in oil prices since last summer, sending WTI not only back under $50, but also wiping out all gains since the November Vienna "supply cut" deal.

With the cartel suddenly finding itself in unfamiliar territory, where neither the daily barrage of "flashing red headlines" sparks a headline-scanning algo buying frenzy, nor the alleged production cuts leading to a reduction in inventory (quite the contrary, US commercial stocks just hit a new all time high) OPEC had no choice but to make a threat to its biggest competitor: US shale companies.

According to Reuters, Saudi energy officials told top independent U.S. oil firms in a closed-door meeting this week that they should not assume OPEC would extend output curbs to offset rising production from U.S. shale fields. The reason for Saudi ire is simple: it is producing less, having shouldered the bulk of OPEC cuts, and yet with prices once again declining, and US shale producers ramping up production, not only are Saudis pocketing less revenue, but they are also are permanently giving up market share to US producers whose production in recent months has soared, especially in the Permian, where breakeven costs are as low as $30 for some producers.

the Permian basin has been leading the increase in horizontal oil rig count (+130%)

As shown before, in addition to generous capital markets which have allowed shale companies, even those on the verge of obtain relatively easy financing, the biggest driver of the recent ramp in production have been technological gains, which have slashed breakeven costs for domestic producers.

Unfortunately for Saudi Arabia, and OPEC, they never considered these two very critical variables. As a result, while oil producers led by Saudi Arabia and top non-OPEC exporter Russia are in an uneasy truce with U.S. shale firms after a two-year price war that sent many shale producers to the wall, the truce is now being violated by the same shale companies which Saudi Arabia launched a massive attack on in late 2014, in hopes of putting the bulk of the space in bankruptcy.

It failed, and now it's payback time, ironically permitted largely by OPEC's own actions.

Following last November's Vienna deal to cut production - which judging by record inventories one can allege never happened - the resulting rise in oil prices has sparked a rush of new output by shale producers, who this week outlined ambitious production growth plans across the United States. That prompted the Saudi to lash out: speaking at an industry conference in Houston, Saudi Arabia's Energy Minister Khalid al-Falih said that there would be no "free rides" for U.S. shale producers benefiting from the upturn.

According to Reuters, Falih's senior advisors even went a step further at the meeting on Tuesday evening with executives from Anadarko, ConocoPhillips, Occidental Petroleum, Pioneer Natural Resources, Newfield Exploration and EOG Resources.

"One of the advisors said that OPEC would not take the hit for the rise in U.S. shale production," a U.S. executive who was at the meeting told Reuters. "He said we and other shale producers should not automatically assume OPEC will extend the cuts."

The irony, of course, is that shale isn't "assuming" anything - it is merely producing as it has recently hedged itself for months to come and more importantly, it is profitable to produce at current prices: it is Saudi Arabia who, in a desperate attempt to boost interest and demand for its upcoming Saudi Aramco IPO, had no choice but to concede that its November 2014 decision to temporarily break the cartel was a mistake, and it alone was instrumental in getting last year's production cut deal together. It's even more ironic that should OPEC's production cut deal not be extended into the second half, oil prices will tumble as the Vienna "deal" is promptly forgotten, and the Saudi financial crisis which several months ago sent Saudi financial stocks crashing and bets on Riyal devaluation to all time highs, will quickly come back, backfiring on Riyadh far more than on US shale. Oh, it also likely means a far lower valuation for the Aramco IPO.

The Saudis, who we recently learned had been colluding with hedge funds to learn about the "speculative" mindset and to gauge why there has been little faith and confidence in OPEC actions, called the meeting to exchange views on the market and to gauge the outlook for shale output, Reuters' sources said.

After slamming shale companies on Tuesday for their impudence to, well, do their job, Falih then said that global inventories had fallen more slowly than he expected in the first two months of the year, although oil market fundamentals were improving as a result of the curbs. He did not provide an explanation for how it was possible that (allegedly) improving supply and demand dynamics would lead to greater inventory.

Then on Wednesday, as if in a coordinate liquidation, oil prices plunged 5% to lowest levels this year after U.S. crude inventories surged to a record high, in part because of rising output from shale producers. The price drop continued on Thursday. According to one narraitve, the inventory rise stoked concern that the glut could persist because shale supply, along with more output from Brazil and Canada, could offset output cuts by OPEC and some non-OPEC suppliers.

That, of course, makes little sense as inventories had been at record levels for weeks. Far more likely is that speculators, already at record long positions, started selling, and the initial trickle quickly became an avalanche as margin calls went off, prompting even more selling.

Meanwhile, the the EIA announced it expects U.S. oil output to rise 330,000 bpd in 2017, mostly from shale, but some analysts and producers are forecasting the increase could be more than double that amount. In any event, absent another big drop in oil prices, US production will soon surpass its previous all time high in the mid 9 mmbpd range.

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As for OPEC, aside from panicking, it now has few other viable options. The cartel next meets on May 25 in Vienna to discuss supply policy, and is expected to decide there on whether to extend supply curbs implemented at the start of the year. Should oil prices continue to slide, while shale production ramps even higher leading to even greater market share loss for Saudi Arabia, the Kingdom, finding itself in a lose-lose situation, will likely let the production cut lapse and revert to the old "every OPEC member for himself."

For now however, it's all smiles: in a joint news conference on Tuesday, Falih, Russian Oil Minister Alexander Novak, Mexican Deputy Secretary of Energy Aldo Flores, Iraqi Oil Minister Jabar al-Luaibi and Secretary-General Barkindo, said they were happy with compliance by the pact's members so far. Just don't show them where oll closed today.